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The commercial real estate sector may be in for further bumps in the road in the year ahead – but its current predicament is by no means a crisis, according to a prominent market analyst.

Marie-France Benoit, principal, director market intelligence at Avison Young, told Canadian Mortgage Professional that while high interest rates and borrowing costs are likely to persist in the coming 12 to 18 months, the commercial market has always been cyclical, with opportunities arising even amid challenging times.

The cost of financing likely won’t rise significantly beyond its current level, but will still probably stay higher than what the market has traditionally been accustomed to, Benoit said.

That could see some market participants struggle, although others are likely to find opportunity even in a difficult market.

“When the cost of financing increases and also lenders are being more cautious, the supply of money available to lend is not as abundant, so lenders are more selective,” she said. “So that means that not all projects will get financing as easily as they would have five years ago, and the cost of it increases.

“So we’re expecting that [for] the developers that don’t necessarily have the liquidity, we could see a few situations of distressed properties. But then, there’s usually a time in a cycle where some investors are doing extremely well because then it opens a window of opportunity for certain buyers in those times.”

Long-term nature of commercial real estate investing underlined

Benoit emphasized that investing in commercial real estate has usually been a longer-term project than in other sectors, with the full benefits often not becoming apparent until much further down the line.

“When you invest in commercial real estate, it’s not for two years. It’s more like 10, 15, 20 years,” she said. “So how do you want to position yourself when we’re out of that short-term ‘crisis’? I wouldn’t call it even a crisis.

“I would say that it’s going to be some turbulence with financing being less abundant and more costly than it was in the previous 10 years.”

Differences between the banking sectors of the US and Canada, meanwhile, mean there’s little prospect of a meltdown north of the border linked to commercial real estate challenges, according to Benoit.

“When the banks are being more cautious, that has a direct impact on commercial real estate,” she said. “But it’s not like in the US – the banks here are not as exposed, [and] their underwriting is stricter than the US, so that’s why I don’t want to use the word crisis. More like turbulence.”  

Current slowdown makes forward outlook murky

Market uncertainty looking ahead to 2024 is partly because of the slowdown in transactions this year, Benoit said, with a decline in sales volumes and activity meaning there are few comparable transactions, leases, and sales at present – essential components of a healthy commercial real estate market.

“What I feel now is that it’s hard to know what the terminal cap rate will be if you exit your investment,” she said. “And when the market players are dealing with an opaque situation where a lot of data is not available to them, then you have to buffer for the risks because there is an element of risk that comes from this lack of free-flowing information.”

That means market players are, to some extent, “navigating a little bit in the dark” for the year ahead, with investors likely to expect higher yields to offset greater risk because of that uncertainty.

Obsolescence will also be a big theme moving forward, Benoit said, with a need to stay focused on making sure buildings that are falling into disrepair or lack of use become fully optimized in the years and decades ahead.

“Every year we get older, but so do the buildings that we are occupying, whether it’s your apartment, or house, or office,” she said. “There’ll be questions with ESG [Environmental, Social, and Governance]: ‘What’s the best use of the site?’

“Some of the properties are obsolete. They need to be repurposed, and that’s a great opportunity to rethink our cities as well… in the next 12 to 18 months everyone will be pretty focused like they have been in the last year about interest rates and things like that, but let’s not lose sight that the buildings that we are occupying now, that we’re investing in now, they’ll be here in 20 years and 30 years.”

Source: Canadian Mortgage Professional